d. Consider a stock with a current price of P- $27. Suppose that over the next 6 months the stock price will either go up by a factor of 1.41 or down by a factor of 0.71. Consider a call option on the stock with a strike price of $25 which expires in 6 months. The risk-free rate is 6%. (4.) What is a replicating portfolio? What is arbitrage? If you borrow an amount equal to the present value of the riskless payoff and buy Ns shares of stock, the payoffs of this portfolio replicate the payoffs of the call option. PV of riskless payoff- Amount borrowed Repayment of riskless payoff Payoff if stock is up Stock price Value of stock in portfolio Less repayment of borrowing Net payoff of portfolio Payoff if stock is down: Stock price Value of stock in portfolio Less repayment of borrowing Net payoff of portfolio- Notice that these are the same payoffs of the option